This past Friday I visited Capitol Hill, and spoke to staffers for three different senators and one congressman. In my view, it is not appropriate for Congress to tell the Fed exactly how to do monetary policy—it’s better to set broad objectives. Thus I do not think Congress should mandate NGDP targeting, although I favor having the Fed adopt that policy. But I also believe that there needs to be more transparency and accountability in monetary policy. I gave each staffer a Mercatus policy brief on my views in this area; here’s a short excerpt:

In this paper, I’ll propose an alternative approach to accountability and transparency, which I believe is both more useful and more politically acceptable. In this regime, the Fed would first set specific quantifiable goals, then conduct annual evaluations of past policy decisions. The Fed would then tell Congress whether, in retrospect, the previous year’s policy stance had been too expansionary or too contractionary, and it would also provide specific metrics to justify this appraisal. . . .

Conclusion

While previous proposals to “audit the Fed” have been fiercely resisted by the Fed leadership, this proposal for boosting transparency and accountability is likely to be uncontroversial, with appeal to both political parties. No institution can seriously argue that its performance leaves no room for improvement or that it cannot learn from past mistakes. Indeed, the proposal has several features that might actually be attractive to the Fed chair. First, it will help Congress to better understand the Fed’s motives when unusual policy steps are needed. Second, it will tend to unify the Fed’s own decision-making process. The Fed chair will be less likely to feel like a person “herding cats” with differing views on how to make the dual mandate operational.

Unlike other reform proposals, the Fed will retain its current level of independence under this proposal. It will continue to be free to decide how to interpret the meaning of its dual mandate, to decide which policy instrument settings are best able to implement its vision of the dual mandate, and it will also be given the discretion to decide for itself how to evaluate whether past policy settings were too expansionary or too contractionary. That’s an enormous amount of independence for such a key policymaking institution. As a result, it’s hard to imagine the Fed putting up much resistance to the proposal.

Read the whole thing.

PS. There’s a “Straussian reading” of the proposal, which would be much more impactful than it might appear at first glance.

We come back, over and over again, to an age-old problem: How does one hold an independent public institution “accountable”?

So the Fed misses a target. So what?

Congress or the President cannot fire the Chairman, or any of the board of governors. The District Presidents (who have five votes out of 12 at FOMC meetings) are selected by a mysterious process so deep into the weeds that Fed scholars have to refer to textbooks to remember it.

By structure, just two appointed members of the Board of Governors and the five voting district presidents have seven votes, enough to control the FOMC. Wishing to look Olympian, the Fed seeks consent. How to get the district presidents, often tight-money theologians, lightweights, political hacks and even a quack or two (remember Richard Fisher), on board?

Accountability requires the ability of the Congress or President to remove Chairman, and that the Chairman have real power.

There is a secondary problem we may not be giving the tools the Fed needs. If there is not a process to get to money-financed fiscal programs, then the Fed is left with interest rates cuts (near zero bound) and QE. And we are not sure QE works.

“No institution can seriously argue that its performance leaves no room for improvement or that it cannot learn from past mistakes. Indeed, the proposal has several features that might actually be attractive to the Fed chair. First, it will help Congress to better understand the Fed’s motives when unusual policy steps are needed. Second, it will tend to unify the Fed’s own decision-making process.”

I actually think that Sumner’s idea is pretty clever. The point is to get the FED to publicly indicate what it attempted to, and then to publicly report if it met that goal. Humans are social animals, and having to make public your failures is actually a powerful motivator. It is also a document that I am sure would be very closely poured over by bankers and economists, which means that the FED would be giving an account of its actions to be scrutinized by their peers.

An ‘accountability plan’ that lacks a reminder to the Fed that, as in institution, it is a complementary and cooperational cog in the machinery of aggregate national economic policy implementation as well as a definition of and the teeth necessary to enforce healthy boundaries to ensure that it is on the same economic policy page fails to address problem of the tail wagging the dog and is unlikely to prevent occurrence of events similar to those of 2008-12 or on or about 1979.

I understand the need to treat everyone involved with dignity and respect and in the spirit of cooperation, but that notion should be to extended much farther than is apparent to encompass everyone for whom monetary policy is intended to serve to make the point that in a democratic republic, the tail should never be wagging the dog, even when based on a fluidly selective interpretation of legislated mandates that avoids standard rules of construction, the interpretation of a clause in a document should provide meaning to the rest of it rather than infringing upon it.

Congress needs to put a stake in the ground and insist that the tail can no longer wag the dog. That means stepping in to set and enforce healthy boundaries regardless of the opinion of bureaucrats at the Fed, or it will constantly be held accountable for conditions foisted on the public at large that are inconsistent with its policy intentions and not of its own making. The Fed currently does not have appropriate incentives to police itself, intellectually or in any other way, and needs to be provided with them or we shall be victims of independent and unaccountable creative license in perpetuity.

While it seems obvious your kind of proposal makes sense, it should also make sense in all Government activity. But to me, this is whispering into the wind. Operational definitions will be hard to come by; after the fact, (previously unthought of but now deemed critical) events will be used as excuses; ideologues, or just plain opportunists will challenge the need for the action that will make the entity accountable. Anything not driven by market forces will fail. I am losing faith in the ability of any government entity, Fed included, to ever make the right call based on knowledge and the willingness to correct.

But, Paul Krugman and many others have commented on the institutionalization and socialization of Fed members, which of course extends to Fed staffers. Indeed, central bankers become part of a global central-banker community.

Perhaps central bankers will respond to public criticism and shaming after failure.

Well, I wonder if Profe Sumner’s idea is a first step in that direction. Right now, if Trump somehow fired Jay Powell and replaced him, that would seem arbitrary and would seem to threaten the independence of the Fed.

But let’s say that Sumner’s idea is implemented, and has been so far ten years or more. That is, lets say at the beginning of each year, or each quarter, the Fed announces its goals in terms of inflation and employment, and how it expects to conduct monetary policy to achieve those levels of inflation and employment based on its predictions of relevant economic variables. Then, at the end of each period, it has to describe what actually happened with inflation and employment, what it did to influence those two things (via managing aggregate demand). After you have this ritual for a while, you can start to make the case that politicians can adequately judge the performance of the Fed’s board of governors, and should be allowed and trusted to fire them for lack of performance.

What’s more, a substantial portion of the public could probably follow along. There would be three metrics to judge; did the Fed manage to guide aggregate demand (nominal GDP) to the level that it said it would? They may not always do so (real economic shocks do happen and do force difficult decisions on the Fed), but it should be pretty obvious to the public what those shocks are. However, a Fed that consistently misses its NGDP target by a material amount would be one whose governors could credibly be fired for cause (lack of performance). Inflation and employment would be a bit trickier. The Fed can get target, and meet its targets, for inflation, more or less, but only at the expense of having less influence on employment. For these two variables, what you would really want to see from the Fed is doing a good job of forecasting these variables, so that the NGDP target that they set is appropriate.

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.